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December 7, 2011

Revenue Bonuses: Creating an Owner’s Mentality

I got a follow up email on my November IA cover story for Investment Advisor— “Let Go to Grow”—about how our employee revenue sharing program works in an actual practice. The writer was particularly interested in how, as firms grow and add new employees, the addition of new employees affects the revenue share of the existing employees, and how the existing employees feel about that. This is a particularly good question in that it raises one of the biggest unintended benefits of my P4 Principles, which we realized only after putting revenue sharing programs in place. Without going into too much detail, here’s how our programs work—and how they create a very strong “owner’s mentality” in the employees of our P4 firms.

Our employee revenue sharing programs, as the name implies, pays the employees of our client firms regular bonuses (usually quarterly) based on the revenues of the firm. As readers familiar with my work will know, I greatly prefer revenue based bonuses over profit sharing or merit bonuses because they eliminate the conflict of owners minimizing profits and the arbitrary nature and short-sightedness of merit evaluations. What’s more, when employee bonuses are tied to the revenues of their firm, they become highly motivated to come up with innovative ideas to increase those revenues, and much better relate to firm economics when revenues go down. We had zero complaints from revenue-bonuses employees during 2008 and 2009.

Getting to the issue of new employees, we implement revenue bonus programs by setting aside a fixed pool of revenues each quarter, usually between 10% and 15% of revenues. Each employee, then, has a fixed share of that pool. But, at least in the beginning, we only allocate a portion of the pool, say 75% or 80%, leaving some revenue-sharing potential for new employees when and if they are added. That way, when additional employees are inevitably added to a growing firm, it doesn’t directly affect the bonus share of the existing employees. Of course, eventually a firm will

add more new employees than we allowed for. Then, the addition of each new employee will mean a reduction of every employee’s revenue share (even though the actual dollar amount of every employee’s revenue bonus will continue to increase as the total revenues of the firm grows).

Because all this is fully disclosed to firm employees upfront, as well as the total revenues of the firm—up or down—each quarter, we’ve never had a complaint or even any pushback about revised revenue shares as our firms grow. But what we have seen, to an extent that even surprised me, is the extent to which our revenue-based employees will come up with alternatives to adding costly new employees; a true owner’s mentality.

It’s been my experience in businesses, large and small, that employees are usually constantly whining about how over-worked they are, and how they desperately need more help. Not in my P4 firms. Because new employees literally mean a smaller piece of the pie, they are considered the absolute last resort—after every other solution has been tried and/or discarded.

I am constantly surprised at the ingenuity of employees to come up with ways to leverage themselves, their coworkers, and their firm owners—through technology, new systems, rearranged responsibilities, etc.—to keep employee costs down. And then, when everyone finally sees that new employee is a necessity, we hear no complaints: that buy-in motivates existing employees to work together to make the new employee as productive as possible, as quickly as possible. It’s a team effort that you really have to see to fully appreciate—and it’s all made possible by the owner’s mentality created by revenue-based bonuses.

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